Forex and the Euro Stress Tests

Much like the bank stress tests in the USA, the standards for the Eurozone were subjective, lax and led to questionable results at best. Nevertheless, when the US results were released, it immediately supported the markets, inspite of the rather generically positive results.

As I mentioned last week, no Central Bank likes to release sour data, and the oversight board, the Committee of European Banking Supervisors, (CEBS) gave us no surprises. They did not release the time of their findings in advance and the whole world waited with bated breath to see what they would say (except us, of course). Strategically, they chose to release the results after the European markets closed on Friday, knowing that there were only a few hours left in the trading week, and that most of the traders had left their desks for the weekend. This gave an additional several days for traders to examine and mull over what the findings really were.

Here's the skinny, and you make of it what you will. Overall standards were fairly lax as the CEBS was looking for a capital requirement of 6%. To set that in comparison, the Swiss stress tests used a stiffer 8% baseline. Had that been used in Europe, the results would have been disastrous. Also, the seven firms that fall short of the capital requirement of 6% are already supported by the ECB in one way or another, so their threat is muted. Also, the whole purpose of the tests from the beginning was purported to be examining the exposure to a sovereign default, or severe regional crises. In the end, it does not appear that these items were even addressed (would you care to hazard a guess why?).

As it stands now, with the bond rates having very little differential between the two economies of the EZ and USA, the drift will likely be left to the one who has the likelihood of quickest sustainable recovery. Now that is a tough question!

When the tests were finished, the board determined that the total amount of capital that needs to be raised by the under capitalized banks is about 3.5 billion euros. The lowest economist' estimate was 35 billion, ten times as much as officially reported. In this case, I'm betting on the economists.

Also last week, the US reported that the budget deficit was going to be lower than expected. Instead of 1.6 trillion, it will only be 1.47 trillion. Of course, that's up from the 1.4 trillion last year. Sadly, the further out we look, the gloomier the forecasts become. Is America setting itself up for a bang-up recovery? Not with all this debt.

Nevertheless, our counterpart nations are dealing with debt problems that are equally staggering. In a spike of fear, the US dollar will still be the beneficiary, and as the world's reserve currency, we still have the advantage of the fact that economies around the world need US dollars to purchase every commodity which is settled in US dollars (like oil).

We'll keep watching to see if these realities bubble to the surface.

Happy Trading
Bill
bill@thefxtradingmasters.com
www.thefxtradingmasters.com